Rate Cut Resistant: Market Surges Forward Without Interest Rates Cuts

Today the market was lifted on positive sentiment, due mainly to the release of the hotly debated, political football we normally call the unemployment rate number. The dramatic drop in the jobless rate caused a market rally despite political prognosticators weighing in with conspiracy theories of a nothing short of a complete takeover of the BLS (Bureau of Labor Statistics). I will not opine on the validity of the senior economists and staff of that institution--mainly because I know it sounds intellectually foolhardy. BLS junta aside, there were significant other rate factors to consider.

On Thursday, both the Bank of England (BOE) and the European Central Bank (ECB) declined to cut interest rates, which was in line with expectations. The BOE also declined to add to its Asset Purchase Target (APT), another acronym in the alphabet soup of names for quantitative easing programs, leaving it on hold at 375 billion. The general sentiment is that lowering interest rates will not help to cure what is really ailing European economies: ailing banks resulting in a dearth of credit for businesses and consumers alike. This is mainly due to BASEL III requirements and will be covered extensively in Basel Barriers. Additionally, the central banks likely wanted to allow the current programs some time to take effect before acting again. This is of particular import because during a visit to the Bank of England this summer, I had a discussion with a senior bank official on the BOE's future plans to reduce collateral requirements in an effort to increase lending to small business and non-financial companies. This can significantly impact the lagging UK economy by directly addressing the significant lack of credit.

The lack of credit stems from European banks' efforts to restore risk-adjusted capital adequacy ratios mandated by Basel III; lowering interest rates will not address this. Creating money and handing it to the banks, on the other hand, might. So it is possible, even likely, that the BoE will follow the Fed's lead and ease monetary conditions further in November. Basel will remain a significant impediment to the the banks, I will explore that in depth in an article called BASEL Barriers.

In regards to the ECB, more important than the rate decision itself was the press conference that followed. Capital market participants were looking to Super Mario to provide more insight about the OMT (Outright Monetary Transactions), the ECB's new bond purchase program--the main query being when would the ECB begin to intervene in sovereign debt markets. There was a general lack of detail provided by Mr. Draghi as expected. The Ex-Goldman investment banker declined to answer questions about Spain's request for a bailout and reiterated that the ball is now in the hands of the individual countries to get the OMT going. This was a point that I outlined in Quantitative Easing in the Eurozone. Draghi was dodgy because there are several technical hurdles to implementation of the OMT . There are two prevalent factors to consider 1) Governments will not be eligible to participate in the OMT until after they've requested a bailout from the European Stability Mechanism (ESM) and have agreed to the attendant economic reform conditions. This makes the request from Spain the catalytic event beginning the process, Signore Draghi won't risk his credibility by initiating prior to that event. At this time, neither Spain nor Italy has made such a request, and both have indicated no intention to do so anytime soon--at least not until they can garner the most positive terms for the acceptance of the cash. 2) The ESM itself still has not technically been formed or funded, and it is unlikely that will be done for several more months. Given the previously stated factors--we won't be seeing any OMT bond purchases anytime soon--much to the chagrin of the crowd clamoring for more intervention. For everyone in capital markets feeling the pain from the lack of action, I can only offer a prescription given by the Greek sage healer Hippocrates "Cuivis dolori remedium est patientia" of which the translation is "Patience is the cure for all suffering". Unfortunately we must continue to wait.

Baldwin has a Masters in Financial Strategy from the University of Oxford, and also completed the Oxford Global Investment Risk Management Programme. Baldwin graduated with honors from Antioch University with a BA in Management. Mr. Baldwin successfully completed Harvard Bus...